Obscure inflation metric gives Fed fresh reason for confidence

Top Federal Reserve officials — including Chair Jerome Powell — are increasingly pointing to an obscure price gauge as a reason to maintain confidence in their outlook: “market-based” inflation.

The metric excludes a range of services where data-collectors can’t directly measure prices and have to estimate them instead. The result is a different inflation picture in recent months. Whereas the central bank’s preferred underlying inflation gauge accelerated to 2.8% in November, the market-based measure has been more or less flat at 2.4% since May.

The distinction is significant amid an upswing in Treasury yields as investors have soured on the chances of Fed interest-rate cuts in 2025. While US central bankers have signaled they need to see more progress toward their 2% target before they reduce borrowing costs again, repeated nods to the alternative gauge could indicate a lower bar to additional easing.

Fed Governor Christopher Waller, who believes inflation will continue to cool, laid out the rationale for paying attention to the alternative market-based measure in a speech Wednesday as he offered support for additional rate cuts this year. 

“Inflation in 2024 has largely been driven by increases in imputed prices, such as housing services and non-market services, which are estimated rather than directly observed and I consider a less reliable guide to the balance of supply and demand across all goods and services in the economy,” Waller said.

Minutes from the Fed’s latest meeting, also published Wednesday, showed “many” policymakers shared Waller’s view.

The market-based version of the personal consumption expenditures price index excludes several items that government statisticians have to estimate, or “impute” in the parlance of economists, because they don’t have the benefit of observing actual prices paid by consumers for those services.

Some of the big ones that don’t make the cut are portfolio management and investment advice — which largely tracks stock prices, meaning that the equity rally in recent months has pushed inflation higher — and several types of insurance. 

Select categories excluded from market-based PCE:

• Gambling
• Financial services furnished without payment
• Portfolio management and investment advice services
• Life insurance
• Medical care and hospitalization
• Net motor vehicle and other transportation insurance
• Net foreign travel

Powell also nodded to such “non-market services” as a factor behind the recent upturn in inflation in a Dec. 18 press conference, as did Fed Governor Adriana Kugler in a Jan. 3 CNBC interview. 

The case for setting imputed prices aside is that they “don’t really have a forward-looking forecasting signal” for where inflation is going, according to Anna Wong, chief US economist at Bloomberg Economics.

For example, a category meant to capture motor vehicle and other transportation insurance costs rose 6.5% in the 12 months through November — in part reflecting catch-up inflation following a surge in car prices in 2021 and early 2022.

“From a person’s perspective, this inflation is real, but from the Fed’s perspective, they are going to look through it,” Wong said.